Fiscal year 1999 started with an extraordinary natural event. On September 21, 1998, Hurricane Georges hit the Island. Although this atmospheric phenomenon, although did not cause any fatalities, it affected the island's infrastructure, indeed, causing all sorts of damages to our economy. In general, the recuperation was swift and was done in a short period of time, with the exception of the agricultural sector. Among the damages, the energy distribution network was down for two days, literally paralyzing the entire economic activity. Approximately 1.3 million clients, equivalent to 100%, lost electric power services. An 84% of the water and sewer services were affected. A total of 1.7% of the clients were without telephone service. In addition, the lines of internal communication suffered considerable damages, with the destruction of bridges and roads with trash dragged by the hurricane winds. The reduction in the economic activity is reflected in the indicators of September and October 1998. Starting in November we began to register signs of solid recuperation. Federal and local aids contributed in the rapid recuperation of Puerto Rico’s economy. The total amount approved by FEMA was $2,529.7 million. We received $ 1,381.0 million from private sources, including insurance companies and the Red Cross. Jointly with the state government contribution, the final amount in restoration funds exceeded $4,000 million. Even though the initial impact of the hurricane was negative, the extraordinary injection of funds that followed influenced favorably the economic activity in fiscal year 1999. A small part of this grand total will be spread to fiscal year 2000.

Taking this panorama into consideration, fiscal year 1999 closed above the initially projected forecast. According to preliminary data submitted by the Planning Board, the economy grew 4.2% during fiscal year 1999, the highest in the 1990s. In fiscal year 1998, gross product grew by 3.1%. All real gross product components registered highs relating to the development in 1998. Among them we can mention, personal consumption, government consumption expenses, export of goods and services and gross internal investment of fixed capital. The performance of FY1999 takes the average real growth rate above the 3% level for the last five years. The expansion registered in fiscal year 1999 surpassed the official projection the Planning Board drafted in February 1999, which included a base of 3%. Several factors had a positive effect over the economic activity during the course of the year, among which the continuous economic growth in the United States, the funds received after Hurricane Georges, the dynamic vitality of the construction industry, the constant growth of tourist activity, and low interest rates. At current prices, the preliminary estimate of gross product for fiscal year 1999 increased to $38,098.3 million, or 9.4%.

The extraordinary development of investment in machinery and equipment complemented a solid expansion in construction registered in recent years. Also contributing to this scenario are the personal consumption expenses, which registered a 6.4% growth in real terms. This development was above the 2.6% reached during fiscal year 1998 and higher than the estimated maximum of 6.1% projected from the Planning Board. Consumers’ confidence in the economy continues strong during the 1994 to 1999 period, and real expenditures increased by an average of 5.2%. A 14.4% increment in the consumption of durable goods, 2.7% in non-durable goods and 6.4% in services induced this increase. Registered import maintained a good growth rate. During fiscal year 1999 exports of goods increased by 15.3%, reaching $34,902 million. The production of chemical products was a factor responsible for the increment in this item. This development combined to last year’s level represents an $11 billion increment in such item between fiscal year 1997 and fiscal year 1999. Likewise, imports hiked to 16.1%, $25,299 million. This is an outstanding rise when compared to fiscal year 1998 when it increased by only 1.9%. The force pushing the import indicator was induced, in part, by the reconstruction activity as consequence of Hurricane Georges.

The real investment in machinery and equipment surpassed that of last year. During fiscal year 1999, investments rose 31.9%, contrary to the 2.1% decrease registered in 1998. This rise do not follow the increase patterns of recent years. This extraordinary rush is also a reflection of the investment to repair damages caused by Hurricane Georges and the investment in construction machinery. The investment in machinery and equipment is composed of the investment that different economic sectors make, mainly private enterprises, classified as capital goods for the production process. Examples of these are computers, air conditioning equipment, industrial production machinery, motor vehicles, construction machinery, etc.

For its forth consecutive year, construction investment, private as well as public, continue significantly boosting the economic activity, registering a 19.9% increase in real terms during fiscal year 1999. Last year this item registered a 12.6% increment. This performance exceeds the level of 12.1% reached in 1997. Along with this, the accrued growth during the last three years, 1995-1999, reached an 87% rate. At current prices the investment in construction during fiscal year 1999 reached $6,635.7 million for a 23.9% increase over last year, when it increased by 14.2%. The investment in private construction rose by 41.0%, to $3, 504.2 million, motivated by a 49.2% increase in the construction of dwellings, which for the second consecutive year surpassed the billion dollars, reaching $2,001 million. In 1999, for the first time in 25 years since 1974, the total value of private construction projects surpassed that of public projects.

Public investment, which has been directed at strategic infrastructure projects, reached $3,131,5 million during fiscal year 1999, for a 9.1% growth at current prices. The value of infrastructure projects was $2,320.4 million. Installation projects include (the Super-Aqueduct on the north coast, dredging of Lake Carraízo, the Tren Urbano, Route 66, Recycling Plant, and tPR-53)

For fiscal year 2000, the construction industry will maintain a positive trend. According to the Planning Board, the investment projections obtained through the survey indicate that the total investment will reach $7,426,6 million, for an 11.9% growth. This increase represents a $790.9 million increment over fiscal year 1999. According to the projections prepared by the Planning Board, the value of the private construction projects could reach $3,670.5 million, for a $166.3 million increase or 4.7% as compared to 1999. Public construction could reach $3,756.1 million, reflecting a $624.6 million rise, or 19.9%.

This section complements the economic situation for fiscal year 1999 using the monthly indicators for the period between July 1998 and June 1999.

According to the Household Survey, total employment during fiscal year 1999 repeated the same growth percentage from fiscal year 1998 and grew at an 0.8% annual rate. The total employment levels of the last fiscal years reflect a tendency due to economic activity expansion. Total average employment reached a record level for the decade. In 1999 the employment reached 1,146,700, which represents an increase of 9,300 jobs over last fiscal year. After a slowdown in the economic growth during fiscal years 1991 and 1992, the economic expansion over the last seven fiscal years has furnished the creation of 169,000 jobs.

Payroll employment, as estimated by the Establishment Survey, registered a -0.7% reduction, decreasing to 983,000. This employment survey is reviewed annually to incorporate changes developed in the non-manufacturing business universe operating on the Island that pay unemployment insurance and in the manufacturing universe appearing in the annual manufacturing businesses census prepared by the Department of Labor and Human Resources. This salary employment survey tends to underestimate employment in economic expansion periods. This has been the experience during the last years in Puerto Rico as well as in the 50 States, where the same survey is conducted. In the case of Puerto Rico, these reviews have been larger than the ones in the 50 states in percentage terms. For example, in 1998 the salary employment growth previous to the review had depicted a reduction of 1.7%. After the review, the rate increased to 0.3%. In this sense, the payroll employment growth reviewed has tended to confirm the outstanding rising trend in total employment estimated by the Household Survey during the last years. The review corresponding to the period from April 1998 to December 1999 should be ready by the end of February or March of 2000.

Unemployment rate in 1999 registered a significant decrease. This marked the lowest level since 1974. In fiscal year 1999, unemployment decreased to 12.5% from 13.6% in the previous year. This variable is related to the labor force and the participation rate. The growth in the labor force is explained in function of the fluctuations in the participation rate and civilians 16 years and older. In 1998, participation rate reached an all time high for the nineties with 48.1%. In times of economic expansion the expectations of finding a job increases, therefore more people enter in the labor force. This action induces an increase in the participation rate. The employment rise of 9,300 new jobs in fiscal year 1999, in conjunction with the decrease of 0.5% in the labor force contributed to a reduction in the unemployment rate.

For fiscal year 1999, manufacturing contributed 14.6% of the total salaried employment, similar to the participation in the U.S. In fiscal year 1999, it decreased 4.5%, following the secular trend in manufacturing employment of several developed countries. In fiscal year 1998 manufacturing employment plummeted 1.6%. It is worth noting that the employment scenario in manufacturing is subject to revision by the Establishment Survey. This revision should be ready between February and March of 2000. The abovementioned preliminary data, which depicted a 4.0% decrease in the manufacturing, decreased after the revision by 1.6%. Trends in the manufacturing sector at global level depict a reduction of personnel and the adoption of more sophisticated, complex, computerized and automated production processes. As a result of these changes, disregarding personnel reduction, the average monthly income in manufacturing increases by 8.1%, to $1,522 in 1999. Apparel, tuna and leather have been the most affected sectors, due to the competition of countries with cheaper labor rates as well as the NAFTA Treaty between Mexico, Canada and the U.S. This same pattern is repeated in the U.S. However, many existing high technology manufacturing companies have expanded their operations on the Island. Employment in the manufacturing industry was in a decreasing trend for four years, from 1991 to 1994, and then it registered increases during fiscal years1995 and 1996. The growth in the manufacturing sector in the Island has been promoted mainly by the expansion of the national economy, especially in exports and the industrial production areas.

A trend in the manufacturing sector at global level is the gradual decrease in employment and the continuous expansion of production. This tendency increased during the last years as many manufacturing industries expanded output to be able to face the global competition. Within this context, regardless of the reduction in employment, manufacturing sector exports registered a 15.3% growth during fiscal year 1999. This is the second consecutive year in which exports register double-digit increases. The last time there was a double-digit increase was in 1990 and 1991. Another interesting development in the manufacturing sector is that for its third consecutive year, during the 1998 fiscal year there was an improvement in the industrial promotion indicators. Industrial promotion continues a positive trend that started in 1995. For the fifth consecutive year committed employment rose from 11,063 during fiscal year 1998 to 12,072 in 1999. There was also an increase in the item of promoted projects. A total of 149 projects were promoted during fiscal year 1999. The final result of these promotions should aid the aforementioned thwarting employment loses in manufacturing.

Another important factor that should also impact manufacturing positively is the new Tax Incentives Act of 1998. This new law reduces the maximum tax rate for those companies sheltered under the current incentives from 14.5% to 7%, eliminating the tollgate tax which is up to 10% over the earnings that companies repatriate from Puerto Rico. In the labor-intensive enterprises case, (apparel, textiles, leather, tuna fish, etc.) the rate is 4%. In cases with mitigating circumstances and with the prior approval of the Secretaries of State, Economic Development, and the Department of the Treasury, the rate could be reduced down to 2%. This new rate is similar to the one offered by other jurisdictions with a great concentration of manufacturing companies, such as Ireland, Singapore, North Carolina, Georgia, and Florida. The new law also includes tax exemption on interests generated by "Investments 2(j)", allowing for these companies to continue investing in the Island. The law also offers special deductions on investments for machinery and equipment, as well as "super-deductions" of 200% over the investment on research and development, besides a 200% deduction on training expenses. On the other hand, to avoid redundancy of tasks and reduce the administrative bureaucracy, a merge between the Administration of Economic Development and the Industrial Development Company was approved. This merge is geared at making more effective the governmental task of promoting and facilitating new investments and the creation of jobs.

The tourist hotel sector was also highly affected with the passing of Hurricane Georges in September 1998. Some hotels were forced to close partially or totally. Total damages reported reached $157.1 million, which represented 5.2% of the total private sector. In general, the tourist activity helped by a special promotional campaign rapidly recuperated and was ready for the winter high season. Tourist incentives directed at investment, the enhancement of tourist promotion, and the improvement of the national economic situation, has had a very positive impact over the tourist situation even though it represents a relatively small portion of our economy. The tourist activity has become an important element of the economic expansion during the last years. In spite of the hurricane, the total number of registered persons in tourist hotels surpassed last year's. Fiscal year 1999 had a total of 1,431,400 persons registered. This amount represents a 4.2% increment, or 57,000 persons more than last fiscal year. During the 1992-1998 period, registrations increased at an average annual compound rate of 8.3%. This expansion has been made possible through the opening of new hotels that added over 2,000 rooms in the last fiscal years. On the other hand, new operators marketing programs and the temporary closing of several hotels as consequence of hurricane Georges or for remodeling purposes hiked the occupation rates in tourist hotels during 1999. The tourist hotel occupation rate registered its highest level at 75.4%, since fiscal year 1990. In the recent years, tourism has stand out as a very important sector by bringing in sources of employment and revenues and by its diversified character. This has been promoted by the adoption of policies and initiatives to encourage investment in this activity. Among them stand out the Tourist Incentive Act of 1993, and the Tourist Development Fund, a subsidiary of the Government Development Bank. The Tourism Company projects over 1,600 new rooms for fiscal year 2000.

Non-resident registration in tourist hotels, which compose 71.5%, maintained its positive trend of the last seven years. Its Increase in fiscal year 1999 was 2.6%, or 1,023,600, equivalent to 26 thousand non-resident tourists more than last year. In 1998 non-residents increased by 14.3% over fiscal year 1997. Residents were responsible for 54% of the growth in tourist hotel in 1999. Between 1992 and 1996 the number of residents registered in tourist hotels grew to a combined annual rate of 18.2%. However, after a decline in fiscal years 1997 and 1998, 1999 represents a positive trend. The decrease in residents during fiscal year 1997 and 1998 was compensated by an acceleration in the growth of non-resident registry. The total registration of residents was 407,400 for the hike of 8.3% over the 1998 level. The opening of new hotel chains in 2000, with modern reservation systems, has positively impacted the hotel activity in the Island.

The sustained growth of the economy of over 3% for five consecutive years, in conjunction with sound control measures, has executed a favorable impact over the government sector.

Revenue collection continued with the positive trend that started in 1992. The $604.5 million dollar increase to $6,507.0 million in 1999 is the highest since 1994, when collections were 15.9% over previous year. The amount reached in 1999 represents a 10.2% increment over last fiscal year. This has provided resources to conduct the reforms and the development of new programs in the areas of health, education, infrastructure investment, and safety. The expense and government investments have a significant multiplier impact over the economic activity. Within this growth in fiscal year 1999, there is a 14.0% rise in taxes. The general excise taxes decreased in 1998, due to the portion of the resources corresponding to petroleum, crude oil and derivatives that were transferred to the Transportation and Public Works Department, in FY1999 recorded an incremented 13.0%. The 5% excise tax, which is a very good indicator of the economic activity, reflected a 12.9% increase.

Electric energy consumption was yet another item affected by Hurricane Georges. After registering the highest increase of the decade with 8.3% in 1998, 1999 shows a 2.7% drop. Decreases are shown during September, October and November with 9.5%, 15.2%, and 11.5%, respectively, in contrast with the same three months of the previous year. All sectors reflect the impact of the hurricane: residential lowered consumption by 2.1%, commercial by 1.5%, and industrial by 5.1%. Between 1992 and 1997 consumption increased at an average annual rate of 3.4%.

As a result to the amendments incorporated to the "Small Business Job Protection Act of 1996," approved by the US Congress and turned into law by President Clinton on August 20, 1996, the tax credit available under Section 936 of the Federal Income Tax Code is currently being phase out over a ten-year period for existing companies, and will no longer be available for new investors. The available salary credit and depreciation in Section 936 was transferred to a new section of the Code, Section 30A, and will also be terminated in ten years. In his 2000 Budget, President Clinton included a measure providing for Section 30A to remain permanently available for those companies that presently operate in the Island as well as for those newly established. Section 936 was one of the main factors in the industrial promotion policy of Puerto Rico, the quality and productivity of the manual labor, high technology in telecommunications, and a relatively modern infrastructure are extremely important in the global competition scenario which characterizes the world economy of today. These factors along with a more agile government, the development of local capital markets, the diversification of the economy, and the development of new incentives, will be the foundation for the entry of Puerto Rico to this new world order.

The perspectives of external factors that affect the performance of the Puerto Rico’s economy point in the direction of a positive economic growth for the years to come. The following stand out among these factors:

The course of the US economy - The economic forecast from the DRI/McGraw-Hill Corporation of December 1999 estimates the growth of the Gross Product at constant prices at 4.0% for 2000 and at 3.3%% for 2001. This projection takes the U.S. economy to a new expansion record and assumes the continuance of the present expansion. The Federal Reserve will keep expanding the economy above average in the long term. The economic and financial panorama shown presently by the Far East indicates that they are in the process of recuperation, therefore, exports will increase. The devaluation of the dollar should also increase product traffic. This is the highest projection risk for the 2000, since it is too early to evaluate the total impact of the crisis and the new developments which may be brought about by these countries are yet to be seen, as well as their impact on the rest of the more advanced economies.

Crude Oil prices - According to DRI/ McGraw-Hill, the price of imported crude oil should reach an average price of $22.00 per barrel for the 2000 fiscal year and later around $19.10 a barrel by 2001. This crude oil price scenario shows a drop over the prices during the last two fiscal years of $15.30 and $12.30 in 1998 and 1999, respectively. Crude oil prices reflect a consistency in the quota that main producers have maintained, as for the increase in the demand from the Asian countries.

US inflation rate - The DRI/McGraw-Hill prognosis on inflation terms indicates a change in trends from last year. Inflation during fiscal year 1998 was at 1.8% and fiscal year 1999 marked a 1.7% level. It is expected that 2000 will still keep the prices low, and a 2.5% rate is projected. Among factors influencing this projection is the economic expansion and the pressure it executes over available resources, especially labor. Additionally, price of crude oil and the recuperation of the Far East influence this projection in a positive way. Even when an increment in interest rates is projected, the level is relatively low and should not have any adverse effect in the growth projection for 2000 and 2001.

Interest rates - The interest rate scenario foreseen for the years 2000 and 2001 reflects the expectation of a moderate increase in inflation. Interest rates are expected to rise over last year's level. The Federal Reserve rose interest rates three times in the second half of 1999. Fiscal year 1999 closed with a primary interest rate of 8.0%. The DRI/McGraw Hill projection for 2000 is of 8.4% and 9.0% for 2001. The increases in 1999 manifest the FED's intention of maintaining economic growth within a moderate inflation frame.

Puerto Rico Planning Board Forecast – The projections by the Planning Board, issued in February 1999, point to a moderate growth rate for 2000. The base projection shows a value of 2.7% and at best-case scenario of 3.0%. The exogenous variables considered by the Planning Board indicate a 2.1% growth rate for the U.S. economy, and $11.90 per barrel of oil. Also, the Board forecasts the prime rate at 7.8% and personal consumption expenditures at 2.6%. The Board, in February had forecast a base growth rate of 3.0% for fiscal 1999, preliminary figures for the year indicate a growth rate of 4.2%.

UIA-Wharton Model Forecast –In the most recent UIA-Wharton model forecast of December 1999, it is foreseen that the Real Gross Product of Puerto Rico will grow 2.85% during fiscal year 2000 and 2.55% in 2001. This projection reflects a pattern of 2.6% for the U.S. in the short term, and a crude oil price that will maintain relatively low. Likewise, interest rates will remain low, where 30-year Treasury bonds are not expected to exceed 6.5%. We also project continuity in the hotel expansion and an inflation rate under 3.0%, according to the deflator of consumer goods of the Planning Board.

Inherent risks in economic speculations - The year 2000 brings about multiple challenges. The world economic panorama is still a threat and has in the capacity of affecting economies of developed countries. The crisis in the Far East countries, Japan and Russia already show signs of recuperation, yet below the levels prior to the crisis. Nevertheless, inasmuch as these economies continue their ascending path their projection increases the probabilities of performance. In 1999 the U.S. hiked three times the interest rates with the intention of maintaining growth, and it is expected that by February 2000 there will be yet another record of expansion. This new frontier opens an economic panorama yet unknown for U.S. economy.

Source: Government Development Bank – Economics Office